Rising instability to push issuers to move early
The failure of SVB and CS were a prelude to a wider credit meltdown
Notwithstanding a few hiccups this year, credit markets have been on good form. But whether the bullish spell lasts for much longer, only time will tell and bond issuers would be foolish to wait and see if they have funding to do.
On Tuesday the S&P iTraxx Senior Financials index was trading at 80bp, close to this year’s low and almost half the level it was in September 2022.
But that does not paint the full picture, which has ugly scenes in the background.
Many borrowers took advantage of Covid-era interest rates to lock in cheap long term funding and have therefore been insulated from one of the most rapid rises in global interest rates in 40 years.
And the fact that labour markets have been strong across most of the western world has helped fuel personal consumption, which has underpinned growth.
But reality will bite when higher risk borrowers need to refinance their cheap debt at much higher interest rates, the like of which have not been seen since before the financial crisis of 2008.
Inevitably, weaker corporate credits with slim margins and fat debts — which have scraped through the past few years on dirt cheap financing — will be pushed over the edge and into insolvency.
This was brought into sharp relief on Tuesday, when the His Majesty's Revenue and Customs, the UK tax collector, said that corporate insolvencies in England and Wales were up 27% in June compared to last year. On a quarterly basis insolvencies reached 6,403, also the highest since since 2008.
Although the US and European economies do not face the same post-Brexit headwinds as the UK, their direction of travel is similar.
Rising insolvencies and lay-offs will hit consumption and economic growth could stagnate from the autumn. In due course the world’s major economies could well tip into recession in the final quarter of this year.
And, interest rates are not the only brake lever that central banks have tugged recently. The speed with which the Federal Reserve, ECB and Bank of England have shrunk their balance sheets can only increase the risk of a liquidity crunch.
The UK’s Gilt crisis, the collapse of Silicon Valley Bank and the failure of Credit Suisse may yet prove to be just the prelude to a broader credit meltdown.
Other highly leveraged, rate-sensitive sectors of the global economy, such as real estate, will before long begin to feel the impact of less central bank liquidity and higher rates.
As credit sentiment begins to sour, issuers will find it progressively more difficult to navigate markets. Opportune funding windows stand to get smaller and further apart as the year progresses.
And though investors will have a surfeit of funds to deploy on their return from summer, every borrower knows this already. In competing for investors’ attention amid a deteriorating fundamental backdrop, there is an ever-present risk that issuers might crowd each other out.
This week Société Générale and Royal Bank of Canada priced €3.75bn of new bonds in the covered bond market, despite the supposed market torpor that sets in after the Bastille Day holiday on July 14..
These deals pay testimony to the view that there is nothing for issuers to gain by waiting. They give credence to the idea that issuers looking to pre-empt September’s supply glut cannot fail to harness a first mover advantage.